Ethanol In the Motor Fuel Pool :Supply, Demand and Policy Considerations

Larry KuminsVice President, Research and Analysis

Energy Policy Research Foundation Inc.At

Center For Energy StudiesLouisiana State University

April 27, 2007

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Introduction

Energy Policy Research Foundation Inc. (EPRINC): successor organization to the Petroleum Industry Research Foundation Inc. (PIRINC) Founded in NY in 1944 Re-imagined in DC in 2007 as EPRINC EPRINC brings policy analysis and industry

economics to bear on current energy issues

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Agenda

Part I: Ethanol Comes of Age—MTBE Replacement

Part II: Corn—Supply & Price Part III: Vehicle Fleet Constrains Ethanol

Consumption Part IV: Oil Refiners—Adversely Impacted? Part V: Energy Security/ Oil Imports

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Part 1: Ethanol Comes of Age

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Ethanol is NOT Oil

Volume vs. Energy Content: Btu content is only 2/3rds gasoline

Volumes do not hold comparable energy value; current $2.17/gal ethanol price is the energy equivalent of $3.24 gasoline

Physical issues: Mix tends to separate; attract water. Can’t be shipped by pipeline

Expensive transport: 75% by rail; 25% truck; oil moves by pipeline at 1/4th cost

Mixture has short shelf-life: blended locally Gallons vs. Barrels: Ethanol industry measures in

gallons per year; petroleum in barrels per day. Optics of large numbers.

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Some Background

Used as a high octane motor fuel since internal combustion invented

Energy Tax Act of ’78 started the federal tax exemption

4 cents/gal “gasohol”

American Jobs Creation Act of 2004—51 cents per gal for ethanol blended

EPAct 05 mandates—4.0 bil gals in 2006; 7.5 bil gal in 2012

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Some Background(continued)

MTBE was a blending component of choice, adding oxygen content and boosting octane. Needed to make oxygenated gasoline.

MTBE Phase-out: In process since 2000 Consumption peaked at about 300,000 b/d Zeroed-out in 2006

Essential and complimentary to making gasoline

Max MTBE use: ~300,000 b/d

Now replaced with ~400,000 b/d ethanol

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Ethanol and MTBE Consumption 2002-2006

0

50

100

150

200

250

300

350

400

2002 2003 2004 2005 2006

000/

b/d

EthanolMTBE

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Ethanol Replaces MTBE - 2006

0

50

100

150

200

250

300

350

400

450

Jan

Feb

MarchApril

May

June Ju

lyAugSept Oc

tNov

Dec

EthanolMTBE

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Ethanol and Gasoline Prices Compared

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Price Update: Ethanol, Mogas, Corn

$2.08 $2.06$2.10

$2.16

$1.36$1.33

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

May-07 Jun-07

RBOBEthanolCorn

Note: Corn prices/2.8 = gallon equivalent price

Source: CBOT and NYMEX near-month futures contracts

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Part II: Corn

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Corn Ethanol Production 2007. . .expect to use 27% of ’07 corn crop for nearly 9 bil. gal.

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1

2

3

4

5

6

7

8

9

10

Bil

lio

n g

allo

ns

0

5

10

15

20

25

30

Per

cen

t

Ethanol Share of Corn ProductionSource: Keith Collins, Chief Economist, USDA. Presentation at the EIA Outlook Conference 3/07

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Corn Prices: 2005 - 2007

Apr

07

Source: USDA; CBCT

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Farmers Respond to High Corn Prices - 2007

Record Corn Plantings - Highest Since 1944 Corn acreage increased 15%

Using land from: Cotton—acreage down 20% Soybeans—acreage down 11%

Price Implications Corn prices fell ~$0.50 per bu on report release.

Cotton and soybean prices will rise because of smaller plantings

Source: USDA, Prospective Plantings. Mar.2007

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High Agricultural Product Prices

Between 2006 and 2007 Corn prices rose by $1.50 to $2.00

Record corn prices increased consumers food cost by an estimated $15 to $20 billion

Cotton and Soybean prices will rise as a result of acreage reallocation to corn

These higher prices will impact the rate of inflation, with adverse macroeconomic impact

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Part III:

Vehicle Fleet Constrains Ethanol Consumption

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Auto fleet designed to use 10% ethanol; it can’t use more Ethanol transport constraints prevent universal distribution

Not all gasoline blenders can get ethanol Less than 100% mogas can be E-10

If higher blends are to be consumed, more E-85 (FFVs) needed in fleet

E-85 vehicles have sold poorly: Out of 237 million vehicles on the road, only 6 million are FFVs Detroit makers pledged half 2012 output will be FFVs; foreign makers not

showing interest In 2017, 280 million vehicles on the road: How many will be FFVs?

Vehicle Fleet Will Slow Ethanol Uptake

Implication: if Detroit succeeds, only 25% of new vehicles sold will be FFVs

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Recap: Role of Ethanol in the Gasoline Pool

% Ethanol

Billions Gallons/

Year

B/D (000)

Fundamental Factor Price Implication

~ %5 ~8 500Necessary- Complimentary—The current situation; replacing MTBE

Higher than Gasoline

5% - 8% ~12 750Enhancing Gasoline Performance and Increasing supply Volumes

Converging on Gasoline Price

10% ~15 1,000

Max % current vehicles can use

Limited by Distribution Infrastructure

Price Competition

among Ethanol Producers

Much greater

than 10%35 2,300

Exceeds likely Auto Fleet Capability

Market Oversupplied—Serious Price

Erosion

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Part IV: Refiners

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Investment: Ethanol Plant vs. Oil Refining

Refining---2003-2006 Refining capacity grew by 0.6 mbd Imports of refined oil product grew by 1.0 mbd U.S. refining capacity continues to lag consumption growth Results in very high refinery utilization w/o capability to deal with outages,

scheduled maintenance, etc. Current gasoline price situation--$2.15 in January; $2.85 in April due to refinery

outages

Ethanol Capacity Grew Rapidly 115 plants operating; 375,000 b/d capacity 86 plants under construction; 400,000 b/d capacity

Ethanol and oil compete for capital and for the same materials and services

Ethanol may be crowding out investment in petroleum refining

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Gasoline Consumption 2017 (mbd):

“20 in 10” Changed Perceptions for Refiners

2017 Gaso Consumption- 1.3 mbd below expected- 0.7 mbd less than 2006

DOE just reduced 2006 estimates of refinery growth—0.7 mbd less capacity in 5 years

“20 in 10”

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Part V: Energy Security/ Oil Imports

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Ethanol Fuels Program Is Costly

$0.51 blender tax credit costs $3 bil per year at today’s rate of consumption. Costs rise as ethanol blending increases.

Because of lower energy value, a gallon of ethanol replaces 2/3rds of a gallon of imported gasoline. At $2.19 per gallon of ethanol, this is the equivalent of ~$3.25 for each

gallon of import saving. The tax credit adds to this.

Should the higher cost of corn to consumers be attributed to the reduction of oil imports?

Should costs arising from price increases in other crops resulting their displacement by corn acreage be attributed to oil import reduction?

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Energy Security Goals: Minimizing Risk

Control Growth/Reduce Petroleum Imports Buffer Economy from Price Shocks Caused

By Adverse World Market Events Encourage U.S. Refinery Capacity Catch-up

With Consumption Reduce risk from refinery mishaps

BUT Depending on An Agricultural Commodity For Energy Supply Introduces New Risks Associated

with Crop Cycle